Tapping your home equity to fund a family loan is legal and common, but it changes two things the moment you draw the money. First, the interest on that HELOC stops being tax deductible, because the IRS only allows a home equity deduction when the funds buy, build, or substantially improve the house securing the loan, not when they get relent to your daughter or your brother. Second, you convert an unsecured family risk into a secured one: if the loan to your relative goes bad, you still owe the bank, and your house is what's on the line.
Most articles on HELOCs stop at "the interest isn't deductible for non-home uses" and move on. That misses the part that actually decides whether this is a smart move: the spread between what your HELOC costs you and what the IRS lets you charge your relative. Run those two numbers side by side and the decision usually makes itself.
The Deduction You Lose the Moment You Relend the Money
IRS Publication 936 is direct about this: home equity loan and HELOC interest is deductible "only if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan." Money you draw and hand to a family member for a down payment, a business, medical bills, or debt payoff fails that test entirely, and it fails it "no matter when the indebtedness was incurred."
This isn't a temporary Tax Cuts and Jobs Act rule waiting to expire. Current IRS guidance applies the buy, build, or improve test with no sunset date, so treat it as the standing rule, not something that reverts if you wait a year. If you were hoping the deduction would come back once the loan closes, it won't; the test is about how the money is used, not when you drew it.
What this means in dollars: if you're in the 24% federal bracket and you can no longer deduct $3,000 of annual HELOC interest, that's $720 a year you're not getting back at tax time, on top of the interest itself. Factor that into whatever you charge your relative, because your true cost of funds is the full HELOC rate, undiscounted by any tax break.
The HELOC vs. AFR Spread Nobody Runs the Numbers On
Here's the part that decides whether a HELOC-funded family loan makes sense: the national average HELOC rate was 7.44% as of August 5, 2026, according to Bankrate's survey of major home equity lenders. The IRS Applicable Federal Rate, the legal minimum you can charge a family member on a loan without triggering imputed-interest and gift-tax rules (see our full breakdown of what interest rate to charge on a family loan), was 4.10% short-term, 4.35% mid-term, and 4.92% long-term for August 2026 (Rev. Rul. 2026-13).
| Loan term | August 2026 AFR (minimum you can charge) | Typical HELOC rate | Your spread if you charge only the AFR |
|---|---|---|---|
| Up to 3 years | 4.10% | ~7.44% | You lose about 3.3 points a year |
| 3 to 9 years | 4.35% | ~7.44% | You lose about 3.1 points a year |
| Over 9 years | 4.92% | ~7.44% | You lose about 2.5 points a year |
On a $50,000 HELOC-funded loan to your son, charging him only the mid-term AFR of 4.35% brings in $2,175 a year in interest. Your HELOC, at 7.44%, costs you about $3,720 a year. You are out roughly $1,545 a year, every year, just to be the middleman between the bank and your family. That's before you factor in the lost deduction on the HELOC side.
You have two ways to close that gap, and both come with a cost. Charge your relative closer to the HELOC rate, and you've recreated a bank loan with your house as collateral instead of a bank's balance sheet, which raises the question of what your relative gained by borrowing from you at all. Or accept the negative carry as the price of helping, which is a legitimate choice, but one you should make on purpose rather than discover on your 1040.
What You're Actually Risking Is the House, Not Just the Relationship
An unsecured family loan that goes bad costs you money and possibly the relationship. A HELOC that goes bad costs you the same things, plus your home, because a HELOC is a second mortgage. Miss payments on it and the lender can foreclose, exactly as with your primary mortgage. Your relative's failure to repay you does not pause your obligation to the bank; those are two separate debts, and only one of them is forgiving.
This is the single most important test before you draw a HELOC to fund a family loan: could you make every HELOC payment out of your own budget if your relative paid you back nothing, ever, starting today? If the honest answer is no, you're not really lending your equity, you're betting your house on someone else's repayment, and that's a materially different decision than choosing to lend cash you already have sitting in savings.
When It Actually Makes Sense
A HELOC-funded family loan is defensible when three things are true at once:
- You can absorb full nonpayment. Your monthly HELOC payment fits your budget even in a zero-repayment scenario, so a missed payment from your relative is an inconvenience, not a crisis.
- The purpose is time-limited and well-defined, like bridging a home down payment ahead of a bonus or a home sale, not an open-ended cash-flow subsidy with no end date.
- You'd rather earn some interest than none. If the alternative is gifting the money outright, collecting AFR-level interest on borrowed funds still beats collecting nothing on given-away funds, even with a negative carry against your HELOC.
If any of those three don't hold, the safer move is to lend only what you already have in savings, point your relative toward a bank loan instead of a family loan for this particular need, or look at whether a smaller family down payment loan sized to your actual cash on hand covers enough of the gap.
How to Structure a HELOC-Funded Family Loan the Right Way
Treat the HELOC draw and the family loan as two entirely separate legal relationships, not one transaction that happens to route through your house.
- Draw the HELOC on its own terms with your lender, and keep records showing the funds were used for a personal loan, not a home improvement, so you don't accidentally misclaim a deduction you don't qualify for.
- Write a real loan agreement between you and your relative, with a fixed interest rate at or above the current AFR, a repayment schedule, and default terms. A free loan agreement generator gets you a signed document in minutes instead of a handshake you'll regret explaining to the IRS or a court later.
- Price the loan using your real cost of funds, not just the bare AFR minimum, once you've run the spread math above. Undercharging is a choice; make it knowingly.
- Track payments separately from your HELOC statement. Family Loan Tracker keeps the amortization schedule, payment history, and interest calculations in one place, so you're not reconciling two debts from memory when tax season or a family dispute arrives.
- Plan the worst case in writing before you fund it. Decide now, not after a missed payment, what happens if your relative can't pay: a formal forgiveness (see our guide to forgiving a family loan without triggering gift tax), a renegotiated schedule, or continued collection.
Alternatives Worth Considering First
Before you touch your home equity, rule out options that don't put your house at risk. Lending cash you already hold in savings costs you only the opportunity cost of that cash, not a secured debt. If the family need is really about funding a relative's business rather than a personal shortfall, decide up front whether a loan or an equity stake fits the situation better, since equity doesn't require either of you to service debt payments at all. And if you're weighing a HELOC against tapping a retirement account instead, know that the rules diverge sharply there too; lending money to family from an IRA or 401(k) carries its own restrictions that a HELOC doesn't share.
None of these alternatives are automatically better. They're simply lower-risk starting points to rule out before you decide a second mortgage on your house is the right tool for helping a relative.
Not tax or legal advice. HELOC and home equity loan interest rules can vary by lender and by state, and your specific tax situation may differ from the general federal rule described here. Talk to a CPA before you draw funds, and to an attorney before you finalize the loan agreement with your relative.
